NOTE 3. 12% SECURED
On April 5, 2012, the Company issued
two (2) twelve (12%) percent promissory notes in the aggregate amount of $250,000 (each a Promissory Note) that mature
upon the earlier of a sale of $1,000,000 or more of the Companys securities or May 4, 2012 (the Maturity Date).
In the event the Company fails to repay the Promissory Notes by the Maturity Date, the Promissory Notes shall thereafter bear interest
at a rate of eighteen (18%) percent until paid in full. The Promissory Notes may be prepaid by the Company at any time if paid
in full. Specifically, the Company issued Ayer Capital Partners Master Fund L.P. a Promissory Note in the principal sum of $245,000
and Ayer Capital Partners Kestrel Fund L.P. a Promissory Note in the principal sum of $5,000. Ayer Capital Partners Master Fund
L.P. currently owns $2,706,146 of the Companys Tranche A Senior Secured Convertible Promissory Notes and Tranche B Senior
Secured Convertible Promissory Notes and Ayer Capital Partners Kestrel Fund L.P. currently owns $76,324 of the Companys
Tranche A Senior Secured Convertible Promissory Notes and Tranche B Senior Secured Convertible Promissory Notes. On May 7, 2012
these promissory notes were exchanged for new notes described below.
From May to July 2012, we entered
into Note and Common Stock Subscription Agreement (the Subscription Agreement) with accredited investors (collectively,
the Purchasers) in connection with the subscription by the Purchasers for certain Secured Promissory Notes (the 2012
Secured Notes) and shares of our common stock.
The 2012 Secured Notes bear an interest
of 12% per annum, mature and were due and payable in full on the earlier of (i) June 30, 2012, (ii) the date on which the Company
has, after May 7, 2012, raised capital (debt or equity) equal to or greater than $1,500,000 in the aggregate, or (iii) a sale and/or
merger of the Company. The repayment of the 2012 Secured Notes is secured with a first lien on all of the assets of
the Company, which lien will be parri passu with the Companys other current and future senior lenders. In addition,
the 2012 Secured Notes are secured by a pledge of all of the shares of Common Stock and by all Common Stock purchase options owned
by the Companys current chief executive officer/ president. Subsequent to the notes issuance, the note maturity date was
amended several times and was extended to December 31, 2012. Except for the change of the maturity date, all of the original terms
and conditions of the Notes remain in full force and effect. Furthermore, the Subscription Agreement provides that if,
at any time while the 2012 Secured Notes are outstanding, we consummate any equity and/or debt financing whereby the terms of such
financing are more favorable than those provided in the 2012 Secured Notes, then the remaining outstanding portion of the credit
facility shall be adjusted to have such terms and conditions similar to those of the new financing. Total cash proceeds received
during the period amounted to $981,250. In addition, the $250,000 in notes were exchanged as described above for a total
of $1,231,250 in new notes.
Upon issuance of the notes,
the Company was required to issue 615,625 shares of its common stock. The Company determined the fair value
of the common stock to be issued was $497,888 based upon the trading price of the Companys common stock and recorded a corresponding
discount to the Notes. The note discount was amortized in full over the original maturity date of the notes and recorded
part of Amortization of discount on Notes in the accompanying statement of operations.
As of September 30, 2012, $1,231,250
remains outstanding and $57,351 in accrued interest which is recorded as part of Accounts Payable and Accrued Expenses in the accompanying
condensed balance sheet.
As of the date of this Quarterly
Report, the notes are currently past due and the Company is in default. The Company has not received any demand for
payment from the note holders and is currently in discussion to cure the default.